India's Depreciating Currency: Why the Panic?

A bank employee counting currency notes in Mumbai. (CPhoto: Indranil Mukherjee / Agence France-Presse)The plunging rupee is the big economics story of the day, and I'm trying to get up to speed on the issues. My immediate question, however, is why the panic?

Yes, the rupee is down a lot in a short time — along with other emerging-market currencies. In fact, according to numbers from the Bank for International Settlements and my estimates based on the dollar-rupee rate, the rupee's fluctuations are small compared with the obvious comparator, Brazil.

We more or less know the story here. First, advanced countries plunged into a prolonged slump, leading to very low interest rates; capital flooded into emerging markets, causing currency appreciation (or, in the case of China, real appreciation via inflation). Then markets began to realize that they had overshot, and hints of recovery in advanced countries led to a rise in long-term rates, and down we went. (I don't think quantitative easing has much to do with it, although your mileage may vary.)

So the recent decline is sharp. But should India panic?

This would be scary if India was like the Asian crisis countries of 1997-1998 or Argentina in 2001, with large amounts of debt denominated in foreign currency. But unless I'm misreading the data, it is not.

Now, the depreciation of the rupee will presumably lead to a spike in inflation — but it should be temporary.

So at first examination this doesn't appear to be as big a deal as some headlines are suggesting. What am I missing?

Generation B (for Bubble)

The flood of money into emerging markets now looks in retrospect like another bubble.

For the moment, I don't see a good reason to believe that the bursting of this particular bubble will be catastrophic — what made the Asian crisis of 1997-1998 so bad was the high level of foreign-currency denominated debt, and that seems less of an issue now. In fact, the main danger, as Ryan Avent recently suggested in The Economist, seems to be policy overreaction: countries raising interest rates to defend indefensible exchange rates, leading to unnecessary slumps. But I have to admit that I'm less certain than usual about my diagnosis, because I'm still coming up to speed on the Indian economy in particular.

Here, however, is a side question: Why have we been having so many bubbles?

The answer you hear from a lot of people is that it's all caused by excessively easy money. But let's think about the longer-term history for a bit. See the chart on long-term interest rates in the United States since the early 1950s.

As you can see, there was a period of very high rates in the inflationary 1970s and early 1980s. Rates fell after the Volcker stabilization in the 1980s, but they stayed relatively high by '50s and '60s standards through the late '80s, the '90s, and even for much of the naughties.

Now, the thing you need to realize is that the whole era since 1985 has been one of successive bubbles. There was a huge commercial real estate bubble in the '80s, closely tied to the savings and loan crisis; a bubble in capital flows to Asia in the mid-'90s; the dot-com bubble; the housing bubble; and now, it seems, the B.R.I.C. bubble. There was nothing comparable in the 1950s and 1960s.

So, was monetary policy excessively easy through this whole period? If so, where's the inflation? Maybe you can argue that loose money, for a while, shows up in asset prices rather than the prices of goods (although I've never seen that argument made well). But for a whole generation?

So what was different? The answer seems obvious: financial deregulation. Banks were set free — and went wild, again and again.

India's Depreciating Currency: Why the Panic?

A bank employee counting currency notes in Mumbai. (CPhoto: Indranil Mukherjee / Agence France-Presse)The plunging rupee is the big economics story of the day, and I'm trying to get up to speed on the issues. My immediate question, however, is why the panic?

Yes, the rupee is down a lot in a short time — along with other emerging-market currencies. In fact, according to numbers from the Bank for International Settlements and my estimates based on the dollar-rupee rate, the rupee's fluctuations are small compared with the obvious comparator, Brazil.

We more or less know the story here. First, advanced countries plunged into a prolonged slump, leading to very low interest rates; capital flooded into emerging markets, causing currency appreciation (or, in the case of China, real appreciation via inflation). Then markets began to realize that they had overshot, and hints of recovery in advanced countries led to a rise in long-term rates, and down we went. (I don't think quantitative easing has much to do with it, although your mileage may vary.)

So the recent decline is sharp. But should India panic?

This would be scary if India was like the Asian crisis countries of 1997-1998 or Argentina in 2001, with large amounts of debt denominated in foreign currency. But unless I'm misreading the data, it is not.

Now, the depreciation of the rupee will presumably lead to a spike in inflation — but it should be temporary.

So at first examination this doesn't appear to be as big a deal as some headlines are suggesting. What am I missing?

Generation B (for Bubble)

The flood of money into emerging markets now looks in retrospect like another bubble.

For the moment, I don't see a good reason to believe that the bursting of this particular bubble will be catastrophic — what made the Asian crisis of 1997-1998 so bad was the high level of foreign-currency denominated debt, and that seems less of an issue now. In fact, the main danger, as Ryan Avent recently suggested in The Economist, seems to be policy overreaction: countries raising interest rates to defend indefensible exchange rates, leading to unnecessary slumps. But I have to admit that I'm less certain than usual about my diagnosis, because I'm still coming up to speed on the Indian economy in particular.

Here, however, is a side question: Why have we been having so many bubbles?

The answer you hear from a lot of people is that it's all caused by excessively easy money. But let's think about the longer-term history for a bit. See the chart on long-term interest rates in the United States since the early 1950s.

As you can see, there was a period of very high rates in the inflationary 1970s and early 1980s. Rates fell after the Volcker stabilization in the 1980s, but they stayed relatively high by '50s and '60s standards through the late '80s, the '90s, and even for much of the naughties.

Now, the thing you need to realize is that the whole era since 1985 has been one of successive bubbles. There was a huge commercial real estate bubble in the '80s, closely tied to the savings and loan crisis; a bubble in capital flows to Asia in the mid-'90s; the dot-com bubble; the housing bubble; and now, it seems, the B.R.I.C. bubble. There was nothing comparable in the 1950s and 1960s.

So, was monetary policy excessively easy through this whole period? If so, where's the inflation? Maybe you can argue that loose money, for a while, shows up in asset prices rather than the prices of goods (although I've never seen that argument made well). But for a whole generation?

So what was different? The answer seems obvious: financial deregulation. Banks were set free — and went wild, again and again.